The Art of the Con--Learning from Bernard Madoff

On a Los Angeles street corner in 2000, I was the "inside man" in a classic con game called the pigeon drop. A magician named Dan Harlan orchestrated it for a television series I co-hosted called Exploring the Unknown (type "Shermer, con games" into Google). Our pigeon was a man from whom I asked directions to the local hospital while Dan (the "outside man") moved in and appeared to find a wallet full of cash on the ground. After it was established that the wallet belonged to neither of us and appeared to have about $3,000 in it, Dan announced that we should split the money three ways.

I objected on moral grounds, insisting that we ask around first, which Dan agreed to do only after I put the cash in an envelope and secretly switched it for an envelope with magazine pages stuffed in it. Before he left on his moral crusade, however, Dan insisted that we each give him some collateral ("How do I know you two won't just take off with the money while I'm gone?"). I enthusiastically offered $50 and suggested that the pigeon do the same. He hesitated, so I handed him the sealed envelope full of what he believed was the cash (but was actually magazine pages), which he then tucked safely into his pocket as he willingly handed over to Dan his entire wallet, credit cards and ID. A few minutes after Dan left, I acted agitated and took off in search of him, leaving the pigeon standing on the street corner with a phony envelope and no wallet!

After admitting my anxiety about performing the con (I didn't believe I could pull it off) and confessing a little thrill at having scored the goods, I asked Dan to explain why such scams work. "We are that way as the human animal," he reflected. "We have a conscience, but we also want to go for the kill." Indeed, even after we told our pigeon that he had been set up, he still believed he had the three grand in his pocket!

Greed and the belief that the payoff is real also led high-rolling investors to fuel Wall Street financier Bernard Madoff's record-breaking $50-billion Ponzi scheme in which he kept the money and paid an 8 to 14 percent annual annuity with cash from new investors. As long as more money comes in than goes out, such scams can continue, which this one did until the 2008 market meltdown, when more investors wanted out than wanted in. But there were other factors at work as well, as explained by the University of Colorado at Boulder psychiatry professor Stephen Greenspan in his new book The Annals of Gullibility (Praeger, 2008), which, with supreme irony, he wrote before he lost more than half his retirement investments in Madoff's company! "The basic mechanism explaining the success of Ponzi schemes is the tendency of humans to model their actions, especially when dealing with matters they don't fully understand, on the behavior of other humans," Greenspan notes.

The effect is particularly powerful within an ethnic or religious community, as in 1920, when the eponymous Charles Ponzi promised a 40 percent return on his fellow immigrant Italian investors' money through the buying and selling of postal reply coupons (the profit was supposedly in the exchange rate differences between countries). Similarly, Madoff targeted fellow wealthy Jewish investors and philanthropists, and that insider's trust was reinforced by the reliable payout of moderate dividends (so as not to attract attention) to his selective client list, to the point that Greenspan said he would have felt foolish had he not grabbed the investment opportunity.

The evolutionary arms race between deception and deception detection has left us with a legacy of looking for signals to trust or distrust others. The system works reasonably well in simple social situations with many opportunities for interaction, such as those of our hunter-gatherer ancestors. But in the modern world of distance, anonymity and especially complicated investment tools (such as hedge funds) that not one in a thousand really understands, detecting deceptive signals is no easy feat. So as Dan reminded me, "If it sounds too good to be true, it is."